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Wednesday April 19, 2006 - 22:24:13 GMT

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Forex: Market So Bearish Dollars that Even Higher CPI Numbers Fail to Halt Its Slide

DailyFX Fundamentals 04-19-06

By Kathy Lien, Chief Strategist of

- Market So Bearish Dollars that Even Higher CPI Numbers Fail to Halt Its Slide
- Will the ECB Verbally Intervene in the Euro?
- Yen Weakness Sweeps the Market

US Dollar

The market has wholeheartedly turned bearish US dollars as we mark its third consecutive day of weakness against all of the major currencies except for the Japanese Yen. Even a dose of stronger consumer prices failed to halt the dollar’s massive slide. Big continuation moves was not unique to dollar today as we saw oil prices make another record high while gold prices made a fresh 25 year high. Inflation remains a force to contend with as headline consumers prices rise by 0.4 percent in the month of March, which was right in line with expectations. Core prices accelerated slightly more than expected by 0.3 percent, indicating that companies have been able to pass more of their rising costs onto consumers. Inflation is expected to continue to move higher in the coming months thanks to the recent surge in oil, which will keep the Federal Reserve hawkish. However as we have mentioned yesterday, the Fed will probably limit themselves to one or two more interest rate hikes as they become more concerned about whether the US will be able to sustain its current pace of expansion. Confirming this notion were more comments from FOMC member Yellen, who has recently been vocal dove. She warned against placing too much importance on one month’s change in annualized CP today, which remained steady at a lofty 2.1 percent against market expectations for a small tick down to 2.0 percent. Yellen also reiterated her belief that the Fed is close to the end of their tightening cycle which is really what the market is focusing on at this point. The more dovish Fed minutes released yesterday has set the tone for the week and possibly even the quarter. Tomorrow’s leading indicators and Philly Fed report will probably help the dollar little. At this point, even if we do see a relief rally in the dollar, sentiment has turned so significantly and based upon fundamentally sound reasons that it will take a major shift in the Fed or Iran’s stance on nuclear development to save the dollar.


The Euro continues to charge forward on the combination of dollar bearishness and stronger German inflation numbers. Producer prices rose 0.5 percent last month, bringing the annualized pace of growth to 5.9 percent. We are expecting the entire Eurozone’s consumer price figures tomorrow and based upon recent data, inflation is not expected to rise significantly. Even if it does, it will probably mean little for the European Central bank, who is probably growing more concerned about the rise in the Euro. The higher the Euro goes, the more it reduces the stimulus in the economy and the more likely the economy will begin to struggle. Therefore even if CPI numbers come in very strong, we would be faced with the same scenario of high inflation in the context of weak growth that they found themselves in during 2004 and 2005. The only solution that they will probably have is to keep delaying interest rate hikes. As we head closer to 1.25, some people expect ECB officials to turn to verbal remedies to halt the euro’s climb which has proven to be of use on a short term basis in the past. This is exactly what they did in early 2004 when the Euro climbed from 1.08 to 1.28 in three months and what they did in late 2004 when the euro rose from 1.23 to 1.37 in two months. However in both instances, the Euro rallied at least 15 cents against the dollar over a very short time frame. Compared to the most recent major low five months ago, the Euro has only appreciated 7 cents against the dollar – probably not enough for the ECB to be worried quite yet. Still, they should not be interested in exacerbating the Euro’s climb by aggressively raising rates. Meanwhile, there is talk that Iceland may consider joining the Eurozone. After a recent bloodbath that took the currency to 4.5 year lows, both the Prime Minister and the central bank Chairman are thinking about abandoning the volatile krona for a more stable euro.

British Pound

The British pound is stronger against both the Euro and US dollar today on little news other than the release of the minutes from April’s Monetary Policy meeting. As mentioned yesterday, the MPC voted seven to one to keep policy unchanged. Stephen Nickell was once again the solitary member to vote in favor of an interest rate cut. Nickell has only one more meeting left on the committee before his term ends on May 31, which means that with his departure the committee will be saying good bye to the one of their most dovish members. However, it seems that he may find a successor for the slot as the minutes indicate that other members believe that the downside risks to the economy are growing.

Japanese Yen

Even though the dollar is capturing the headlines, over the past week the Japanese Yen has really been the weakest currency of the lot. The yen has sold off once again against all of the majors and this time, even against the US dollar. In some pairs like GBP/JPY and CHF/JPY, we are on our seventh day of consecutive yen weakness. Where does this bearishness come from? The answer is the government’s discomfort with the rise in long term yields. Finance Minister Tanigaki has been vocal about his concern for the recent rise in bond yields and has even asked the Bank of Japan to explain to the market their intention of keeping rates low. Instead of doing so, BoJ Governor Fukui on the other hand said that he feels inflation is improving and that rates should reflect economic fundamentals. The conflicting stances raises the worry that we may find ourselves right back where we were last year, which is in the heat of debate between the Bank of Japan and the Japanese government on what to do with monetary policy.


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